Making a success of succession planning

Any Arsenal fans who invest in the Axa Framlington UK Select Opportunities fund will be feeling a loss after their two long-standing managers decided to move on over the past few months.

Research published by Morningstar last year focuses on the aftermath of fund management departures and comes to the surprising conclusion that, on average, there is no significant change in future performance.

Arsène Wenger and Nigel Thomas have both announced giving up long-term positions after heading their respective operations for two decades, and we can only wait to see how their successors, Unai Emery and Chris St John respectively, get on with the task of filling some extremely large shoes.

Without stretching this comparison too far – there have been no 'Thomas out' banners after all – it does shine a fresh light on the subject of succession planning in 'star' based industries, which has increasingly become a key concern for me as a fund selector.

We have seen the emergence of 'retail' fund management over the last 20 or 30 years including the rise to prominence of so-called star managers. When I started analysing funds in the late 1980s, most investors were unlikely to know much about the individuals and teams running their money but many now have high profiles with consumers as well as advisers. And while we might have pulled back from the peak star manager era – there are no more 10-feet high managers on billboards up and down the country – the trend remains well established.

When I started analysing funds in the late 1980s, most investors were unlikely to know much about the individuals and teams running their money but many now have high profiles with consumers as well as advisers.

This tends to lead to intense scrutiny when particular managers leave, with widespread debate, particularly in the press, over whether investors should buy or sell. As holders of Nigel Thomas in our portfolios, we are facing such a decision now but while we often invest in funds based on certain individuals, we have always counselled patience when it comes to moving on if a manager departs.

Research published by Morningstar last year focuses on the aftermath of fund management departures and comes to the surprising conclusion that, on average, there is no significant change in future performance.

"Yet investors overreact and subsequently pull money from these funds: our findings suggest that the fund industry handles succession planning far better than investors react to such changes," the group said.

Investors might disagree based on certain instances in the past – a certain high-profile manager giving up a Special Situations fund after 25 years in the mid-2000s for example – but I would agree there is too much knee-jerk selling when big-name managers leave.

Fund buyers have a tendency to react negatively to manager changes, often wanting to follow the departing individual onto pastures new. But thinking twice about the succession plans in place, particularly with funds from larger investment houses, may save more than time and additional transaction costs.

Going back to Morningstar, the rating agency said investors need to think twice before acting on a manager change, asking whether a fund is one of the "few remaining where the strategy and manager are outside the norm, truly run by a personality or highly specialised individual".

In most cases, it concludes, the answer is no. The most surprising part of the paper is Morningstar's candid reaction to its own track record on manager changes, admitting it has often been unnecessary when it has put funds on watch lists.

"From our study, we find that we do not need to downgrade a fund every time there is a management change if we feel confident in the parent, the process and the cost,'" it added. "We do need to identify cases where there is a policy change in the fund's strategy versus simply a management change."

For me, the key part of this statement is the focus on the parent company and the process – and this very much chimes with our thinking about consistency of process being a prerequisite across our holdings. While a particular investment process is often associated with a specific manager, there is nothing to suggest it cannot pass to successors if the underlying infrastructure is sufficiently robust.

As stated, fund buyers have a tendency to react negatively to manager changes, often wanting to follow the departing individual onto pastures new. But thinking twice about the succession plans in place, particularly with funds from larger investment houses, may save more than time and additional transaction costs.

Looking at a recent example, Ed Legget left Standard Life Investments for Artemis in 2015, passing the SLI UK Equity Unconstrained Fund back to its first manager Wes McCoy.

Reviewing the numbers head to head since Legget took up the reins of Artemis UK Select puts McCoy's fund marginally behind over the past two years. The more interesting story, however, is the similarity in the pattern of returns, with both stockpickers underperforming in 2016 and then among the best in the peer group over the past year.

There will clearly be particular instances where selling a fund when the manager leaves is ultimately the right call for investors. But given the work many groups are putting into succession planning – particularly for top-level managers who have been in place for many years – it is worth taking time over these decisions and not immediately rushing for the exit.

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